A Contribution to Theory of Factor Income Distribution, Cambridge Capital Controversy and Equity Premium Puzzle

TL;DR

This paper develops a comprehensive micro-macro model for closed economies that unifies factor income distribution, addresses the Cambridge capital controversy, and offers explanations for the equity premium puzzle, supported by empirical evidence.

Contribution

It introduces a novel micro-macro framework incorporating both financial and physical capital, resolving key issues in capital theory and the equity premium puzzle.

Findings

Factor incomes follow different distribution rules micro and macro levels

Unified micro-foundation for marginal distribution and no-arbitrage principles

Empirical evidence supports the model's explanations

Abstract

Under very general conditions, we construct a micro-macro model for closed economy with a large number of heterogeneous agents. By introducing both financial capital (i.e. valued capital---- equities of firms) and physical capital (i.e. capital goods), our framework gives a logically consistent, complete factor income distribution theory with micro-foundation. The model shows factor incomes obey different distribution rules at the micro and macro levels, while marginal distribution theory and no-arbitrage princi-ple are unified into a common framework. Our efforts solve the main problems of Cambridge capital controversy, and reasonably explain the equity premium puzzle. Strong empirical evidences support our results.